China’s Repression of Savers Eases

The extra interest Yin Xuelan earned last year by socking her savings into wealth management products instead of bank deposits paid for a tour of Taiwan and a microwave oven.

“I didn’t need to go to Taiwan and I didn’t need to buy a microwave oven, but with this extra money, why not?” said retired schoolteacher Yin, 60, as she put receipts into her pink purse at an Industrial & Commercial Bank of China Ltd. branch in central Beijing. “It’s like free money.”

Yin is a beneficiary of an easing in China’s financial repression, a term that describes the way savers have suffered artificially low returns on deposits in order to provide cheap loans for investment. Measures used for the size of the toll -- such as inflation-adjusted deposit rates, the gap between rates on loans and the pace of economic growth -- have shifted in favor of savers in the past four years.

The burden has dropped to the equivalent of about 1 percent of gross domestic product annually from 5 percent to 8 percent as recently as three to four years ago, estimates Michael Pettis, a finance professor at Peking University. That’s a shift of as much as 2.6 trillion yuan ($420 billion) to households from borrowers from 2010 to 2013.

“It is a turning point,” said Chen Zhiwu, a finance professor at Yale University in New Haven, Connecticut, and a former adviser to China’s State Council. “It will afford more growth opportunities for domestic consumption and the service sector.”

Debt Burden

Financial repression, a concept detailed in 1973 by Stanford University economists Ronald McKinnon and Edward Shaw, refers to policies that force savers to accept returns below the rate of inflation and that enable banks to provide cheap loans to companies and governments, reducing the burden of their debt repayments.

A sustained easing would channel more of China’s wealth to the average person while squeezing bank margins and the debt-fueled investment that’s evoked comparisons with the excesses that generated Japan’s lost decades and the Asian financial crisis. On the flip side, slimmer bank profits may add to risks for an industry grappling with the fallout from record lending in the aftermath of the global financial crisis.

“Many local governments and state enterprises have made low-return investments based on the low-cost funding,” said David Dollar, a former U.S. Treasury Department official in China who is now a senior fellow at the Brookings Institution in Washington. “As the cost of capital rises, some of them no doubt will have difficulty servicing their debts and may even be pushed into bankruptcy.”

Survival Test

Yale’s Chen said the shift will also create more competition and specialization in the financial industry. “Mediocre financial firms and banks will have a tough time to survive,” he said.

Yin earns more than 4 percent annually on the wealth management products she bought from ICBC, China’s biggest lender. The average yield on such products was 5.16 percent in April while for money-market funds it was 4.6 percent, Bank of America Corp. said in a May 20 note.

The products’ interest rates exceed the 0.35 percent benchmark rate on demand deposits, 2.8 percent on a 6-month savings deposit and 3 percent for a one-year deposit. Banks’ outstanding wealth management products rose 44 percent in 2013 to 10.2 trillion yuan, according to the China Banking Association, compared with household local-currency deposits at financial institutions of 48.3 trillion yuan at the end of May.

Gap Narrows

China’s economic slowdown risks making it tougher for companies to repay debt, after years during which they could count on sales outpacing borrowing costs. The gap between the lending rate and growth, unadjusted for inflation, has narrowed to about 100 basis points from an average of about 1000 basis points since the start of 2001, Pettis said.

“This changes everything in China,” said Pettis, author of “Avoiding the Fall: China’s Economic Restructuring.” “First, it is now much harder for borrowers to justify investment in non-productive projects because they can no longer count on the huge gap between nominal GDP growth and the lending rate to bail them out of bad investments. Second, the huge transfer from net savers to net borrowers has collapsed, so that growth in the future must be far more balanced.”

Low returns on savings and cheap loans are root causes of the nation’s reliance on investment for growth, Pettis said. It helps explain why household consumption’s share of GDP fell to 36.2 percent last year from 46.4 percent in 2000, according to researcher Capital Economics Ltd. in London.

Smaller Share

“Household spending accounts for a smaller share of GDP in China today than in any other major economy,” said Mark Williams, a former U.K. Treasury adviser on China who’s now chief Asia economist at Capital Economics. “Only a handful of economies -- mostly big oil producers saving their revenues -- have had household spending account for as low a share of income over the past 50 years as China has today.”

Chinese authorities are transitioning from a system of state-directed credit to one where markets play what Communist Party leaders term a “decisive” role in pricing capital. A floor was removed from lending rates in July 2013 and People’s Bank of China Governor Zhou Xiaochuan said in March that deposit rates will be liberalized in one to two years.

“Three to five years ago there really wasn’t much choice for savers,” said William Hess, co-head of research at advisory firm PRC Macro Advisors Ltd. in Hong Kong. “Households have very quickly reallocated savings to higher-yielding alternatives.”

Higher Risk

Higher returns also mean higher risk. Yet most people view wealth management products as deposits and with increasing evidence of default dangers, that’s creating an issue of moral hazard, Bank of America said in an April 29 note. The term refers to when borrowers take on more risk in anticipation of official aid if their bets sour.

Wealth management products invest in assets including bonds, stocks, currencies, and commodities, though many lack transparency about their underlying assets.

“We will see defaults on wealth management products over the next couple of years,” said Williams of Capital Economics. “Oversight of these products is not as effective as it is of bank lending so there are more unknowns out there.”

The nation’s first corporate default on bonds sold in mainland China and the bailout of an alternative investment product this year have highlighted financial risks that pose a threat to the government’s goal of about 7.5 percent economic expansion in 2014.

Alibaba Fund

Online savings products also have entered the fray. More than 50 have sprouted since last year, including Yu’E Bao, the money-market fund pioneered by Alibaba Group Holding Ltd.’s online-payment affiliate Alipay, which almost tripled its assets to 541.3 billion yuan as of March from December.

At least six other technology companies, including Baidu Inc. and Tencent Holdings Ltd., have embraced Internet financing with similar products that threaten to drain cash from China’s banking system.

Money market funds held assets of 1.9 trillion yuan at the end of May, more than triple the amount a year earlier, according to the Asset Management Association of China.

“The genie is out of the bottle and you can’t put it back,” said David Loevinger, former U.S. Treasury Department senior coordinator for China affairs and now an analyst at TCW Group Inc. in Los Angeles. “It’s largely a good thing. Household income and consumption just became too small a part of the Chinese economy.”

— With assistance by Kevin Hamlin

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